Some things just ought to be left alone. My son and I have often disagreed on this point. "Leave it alone!" "Why are you touching that?" "Stop rolling the window up and down." "Would you please stop pushing that button?" "Don't bother your sister." "Turn the windshield wipers off." "DO NOT PLUG THAT SCREWDRIVER INTO THE POWER OUTLET!"
Many investors to share his tendencies.
Meb Faber wrote a great study on various asset models called Global Asset Allocation. The book is a detailed performance analysis of eight "reasonable" but very different allocation strategies over the most recent forty year period.
These portfolios had stock allocations as low as 25% and as high as 90% (Warren Buffet's famous 90/10 allocation). They included a bond allocation from 10% on the low end to 55% on the high end. Real assets (commodities, real estate, natural resource equities) ranged from 0% in, two of the eight portfolios, all the way up to 50%.
While the reading is admittedly a bit dry, the conclusion is remarkable. Over the forty year period, these eight very different strategies all produced annual returns within 2% of each other (8.5% to 10.4%)!
On the surface this might not seem all that amazing, after all it matches what we've all been told about investing for the long run, right? However, consider that for "shorter" periods of seven to ten years (that surely must have felt like an eternity to under-performing investors) it wasn't uncommon for a given allocation strategy to have been outperformed by up to 100% by other strategies. That brings a whole new meaning to patience, doesn't it?
But the penalty for lacking patience can be harsh. The often quoted and annually updated DALBAR study shows that actual composite mutual fund investors returns have averaged only 2-3% over a thirty year period in which stocks returned better than 11% per year and bonds returned more than 7%. The only possible explanation for this huge performance discrepancy is investors buying after period of price appreciation and selling after periods of losses.
The last few weeks have been an excellent example of the temptation to "touch things" as investors have bid up industrial stocks (e.g. the Dow Jones Industrial Average or DJIA) and sold off gold mining stocks (the Philadelphia Gold and Silver Index or XAU). As often happens when prices change, sentiment (mood) indicators are now depressed for the mining shares and ebullient for industrial stocks. Does this make sense? Thirty years from now, we can be fairly confident that industrial companies will still be doing industrial things, and miners will still be mining gold. Trees won't grow to the sky, and gold won't become worthless. On the contrary, over many years, economic expansions, and recessions, it is quite likely that both US industrial companies and gold will maintain substantial value. However if you had to take either a share of General Electric or a gold coin, and then play Rip Van Winkle for a century, I bet you'd take the coin!
Understanding all of that, why wouldn't a rationale long term investor be more inclined to buy a little bit more of what is on sale and a little bit less of what has been marked up? First of all, my son would tell you it's because sitting still is tough sometime. Secondly, our human brains have learned that doing more of what feels good is fun. But following those normal psychological instincts flat out doesn't work for investing. Prices go up and down as a normal part of markets and the best way to lock in poor long term investment performance is to change strategy when it doesn't "feel good". Fortunately, good habits can eventually be learned with enough reinforcement...my son no longer tries to plug things into power outlets!
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